Section 1035 lets you exchange one life insurance policy for another without paying tax on the gain in the old policy, as long as the money moves directly between carriers and the new policy insures the same person with the same owner. You can also exchange life insurance into an annuity (but not an annuity into life insurance). Before exchanging, compare new surrender charges, a new contestability and suicide period, and how any policy loan will be handled, since a loan that is paid off in the exchange can be taxable.
We are licensed insurance brokers, not CPAs or attorneys. Treat the tax and legal points on this page as general education, and confirm them with your own CPA or attorney before acting.
On this page
What can be exchanged
| From | To | Tax-free under 1035? |
|---|---|---|
| Life insurance | Life insurance | Yes |
| Life insurance | Annuity | Yes |
| Life insurance or annuity | Qualified long-term care contract | Yes |
| Annuity | Annuity | Yes |
| Annuity | Life insurance | No |
The exchange must be a direct transfer between carriers. If you surrender the old policy, take a check, and buy a new one, it is a taxable surrender, not a 1035 exchange.
Why people do it
- Lower costs: an older policy with high charges can sometimes be replaced with a newer design (such as guaranteed universal life) that provides the same or more coverage for less.
- Add guarantees: move from a policy at risk of lapse to one with a no-lapse guarantee.
- Change goals: reduce coverage you no longer need, or move cash value into an annuity for income while keeping the tax deferral.
- Add features: long-term care or chronic illness riders.
A 66-year-old owns a universal life policy bought in 2004 with $180,000 of cash value (on $90,000 of premiums paid) and a $1,000,000 death benefit projected to lapse at 84. Surrendering would create $90,000 of taxable gain. Instead, he exchanges the $180,000 into a guaranteed universal life policy that keeps $1,000,000 of coverage to age 100 with modest ongoing premiums, and his $90,000 basis carries over to the new policy.
What to watch out for
- Insurability: the new policy requires underwriting. Do not cancel the old policy until the new one is issued and in force.
- New surrender charges on the new policy, often for 10 years or more.
- New contestability and suicide periods, usually two years, during which the carrier can review the application.
- Policy loans: if a loan on the old policy is extinguished in the exchange, the loan amount can be treated as taxable "boot" to the extent of gain. Some carriers allow a loan to carry over; otherwise consider repaying it first.
- Same insured and owner: the new contract must insure the same person and generally have the same owner.
- Replacement rules: states require replacement disclosure forms comparing the old and new policies. Read them.
- Variable products: exchanges into variable life or annuities involve securities rules and FINRA oversight.
How to decide
Start with an in-force illustration of your current policy (see the old-policy audit), then compare it side by side with the proposed policy at conservative assumptions, including total premiums, guarantees and surrender values. An exchange should leave you clearly better off, not just different.
Frequently asked questions
Is a 1035 exchange taxable?
Not when done correctly: a direct transfer from one life policy to another life policy or annuity on the same insured. Cash you receive, or a policy loan that is extinguished, can be taxable to the extent of gain.
Can I 1035 exchange an annuity into life insurance?
No. Section 1035 allows life to annuity, but not annuity to life insurance.
Does a 1035 exchange restart the contestability period?
Yes, the new policy generally has its own contestability and suicide periods, usually two years. That is one reason not to exchange casually.
Start your life insurance request
Tell us what the coverage is for and who it would cover. For most requests we ask for each person's date of birth and sex so Erik can prepare for the call. We do not ask health or tobacco questions in this initial request. This is a request for help, not an insurance application or a promise of coverage.
Written by Erik Moran
Erik co-owns Moran Insurance Group with Amanda Moran and handles the agency's life insurance cases, from key person and buy-sell coverage to trust-owned policies. He works alongside clients' CPAs and attorneys, who make the tax and legal calls. More about Erik.
Sources
Moran Insurance Group is a licensed insurance agency. Our brokers are not CPAs, attorneys or tax advisors, and nothing on this page is tax, legal or investment advice. Tax figures and rules reflect our understanding as of October 2026 and can change. Coverage is subject to carrier underwriting and state availability. Confirm anything tax or legal with a licensed CPA or attorney before you act on it.